Participants

Ryan Cieslak; Director - Investor Relations and Treasury; Applied Industrial Technologies Inc

Neil Schrimsher; President, Chief Executive Officer, Director; Applied Industrial Technologies Inc

David Wells; Chief Financial Officer, Vice President, Treasurer; Applied Industrial Technologies Inc

David Matthew; Analyst; Bert

Ken Newman; Analyst; KeyBanc Capital Markets

Chris Dankert; Analyst; Loop Capital Markets

Sabrina Abrams; Analyst; Bank of America

Brett Lindsay; Analyst; Mizuho

Presentation

Operator

Welcome to the fiscal 2025 second quarter earnings call for Applied Industrial Technologies. My name is Liz and I'll be your operator for today's call. (Operator Instructions). Please note this conference is being recorded. I will now turn the call over to Ryan Cieslak, Director of Investor Relations and Treasury. Ryan, you may begin.

Ryan Cieslak

Okay. Thanks Liz and good morning to everyone on the call. This morning, we issued our earnings release and supplemental investor deck detailing our second quarter results. Both documents are available in the investor relations section of applied.com. Before we begin, just a reminder that we'll discuss our business outlook and make forward-looking statements.
All forward-looking statements are based on current expectations, subject to certain risks and uncertainties including those that are detailed in our SEC filings. Actual results may differ materially from those expressed in the forward-looking statements. The company undertakes no obligation to update publicly or revise any forward-looking statement. In addition, the conference call will use non-GAAP financial measures which are subject to the qualifications referenced in those documents.
Our speakers today include Neil Schrimsher, Applied's President and Chief Executive Officer and Dave Wells, our Chief Financial Officer. With that, I'll turn it over to Neil.

Neil Schrimsher

Thanks Ryan and good morning, everyone. We appreciate you joining us. I'll begin today with perspective on our second quarter results and current industry conditions followed by some thoughts on the recent acquisition of Hydradyne and expectations going forward. They will then provide additional financial detail on the quarter's performance and updated outlook, and I'll then close with some final thoughts.
Overall, we had a productive second quarter that highlights the operational resiliency and self-help opportunities of our differentiated industry position and strategy. We grew earnings and expanded margins over the prior year in an environment where demand remains soft and sales declined slightly. We also made progress in positioning the company for stronger growth moving forward. This includes ongoing investment in our sales tools and operational systems and technical talent.
The building of business funnels, which is driving stronger orders as well as the announcing and closing of our strategic acquisition of Hydradyne which I'll discuss in more detail in a moment. As it relates to the quarter's results both EBITDA and EPS exceeded our expectations increasing approximately 3% and 7% over the prior year respectively.
We benefited from strong gross margin performance and cost controls while low [FICO] expense contributed to margin performance in the quarter, both gross margins and EBITDA margins still expanded nicely over the prior year when excluding the change in LIFO expense. The positive performance was primarily driven by channel execution and ongoing margin initiatives across various areas of our business, as well as variable expense adjustments and cost control inherent to our model and operational discipline.
Margin improvement was led by our engineered solutions segment where EBITDA margins expanded 115 basis points over the prior year and exceeded 16% for the first time.
Our engineered solutions segment EBITDA margin has expanded over 450 basis points the past five years. We're making solid progress with our internal initiatives and operational enhancements as we continue to scale this strategic area of our business.
The segment's margin expansion highlights the strong market position and value proposition. We have across our portfolio of fluid power, flow control and automation solutions and should enhance our mixed tailwind and overall margin expansion potential moving forward as segment sales begin to reaccelerate.
As it relates to topline trends, average daily sales declined 3.4% over the prior year, which was in line with the guidance we provided in October of down mid-single to low single digits. We continue to operate within a muted in market backdrop with customers conservatively managing MRO spending and delaying capital investments.
Underlying demand improved slightly following the slow start to October but moderated and was below normal seasonal patterns during December. Most of December's weakness was concentrated later in the month and in our view was primarily tied to the timing of holidays this year with Christmas and New Year's falling midweek as well as extended customer plan idling and deferred maintenance activity within our service center segment.
We estimate softer sales during the last two weeks of December negatively impacted the quarter's overall organic sales growth by approximately 100 basis points. When looking at our top 30 in markets, 11 were positive year over year in the second quarter which is below the 13 reported last quarter. In markets that were up year over year included chemicals, food and beverage, pulp and paper and technology. This was offset by declines primarily in machinery, transportation, aggregates, fabricated metals, oil and gas and mining in markets.
Mixed in-market demand has continued in the early part of our fiscal third quarter as customers are settling into the new year and continue to operate at a gradual pace. Of note, January sales are currently trending down a mid single digit percent year over year on an organic basis. We believe ongoing macro policy and interest rate uncertainty remain headwinds.
Weather has played a role across the Southern US region over the past month as well. That said we do not view January sales as indicative of how the third quarter and the balance of the year could play out based on several directionally positive trends taking shape. Of note, various industrial macro data points are showing some signs of improvement.
The new orders component of the ISM index was in expansionary territory in November and December. Bookings across our service center network are improving following a slow end to December while feedback and sentiment among customers are more positive post the election. Our service center segment is well positioned as inmarket demand reaccelerates, with approximately 50% of our service center business tied to technical break fix situations across critical industrial processes, systems and infrastructure.
We believe demand for our service and products and technical support could ramp quickly and broadly over the next year as customers reengage production and catch up on required technical MRO activity. This will be particularly evident across heavy manufacturing, machinery, mining, metals and aggregate markets, given their brake fix intensive nature and deferred maintenance in recent periods.
In addition, a lighter regulatory agenda with the New US administration represents a potential incremental new tailwind in many of our legacy in markets across our service center operations as well as within our flow control network. Combined, we estimate these break fix intensive and more regulated markets represent about 40% to 50% of our total sales today.
In addition, order momentum and business funnels are building across the technology vertical which represents approximately 15% of our engineered solutions segment and 5% of our overall sales.
We're beginning to see stronger demand across the semiconductor sector and related spending on wafer fab equipment following the demand headwind, we experienced in this sector over the past several years. Stronger customer activity across the technology vertical is encouraging and a potentially strong growth tailwind moving forward.
We also continue to see positive momentum developing across our automation business with orders strengthening year-to-date as various secular tailwinds continue to positively influence demand. These dynamics are driving ongoing adoption of collaborative and mobile robots, machine vision and IOT solutions.
A strong application and engineering capabilities along with an expanded footprint and facility capacity will further supplement our potential in this high growth area of our business. As discrete automation investments reaccelerate in coming quarters and demand for aftermarket and service support starts to emerge. On another encouraging note, order trends are beginning to stabilize and improve slightly across fluid power industrial and mobile OEM customers. If you recall, this has been a primary area of sales weakness for us over the past year.
During the second quarter, reduced sales from industrial and mobile OEM, fluid power customers negatively impacted our consolidated organic year over year sales growth rate by approximately 150 basis points. However, related orders from these customers were up 9% sequentially from the first quarter and relatively unchanged year over year during December.
Combined with more normalized OEM inventory levels following recent destocking and much easier comparisons, we expect the year over year sales trend and related impact in this area of our business to improve moving forward. This includes potentially reemerging as a growth tailwind in coming quarters, considering secular demand and required investments developing across fluid power systems, as well as ongoing strategic investments, we are making into this more specialized and highly technical area of industrial distribution.
Of note, we are extremely excited about the growth and operational momentum we expect to build following the completion of our hydro acquisition at the end of December. Based in Dallas, Texas, Hydradyne is one of the largest us distributors focused on fluid power and motion control systems with advanced service capabilities and product offerings in hydraulics, pneumatics, electromechanical instrumentation, filtration and fluid conveyance.
The addition of Hydradyne aligns extremely well with our strategy with anticipated sales of $260 million and EBITDA $30 million in the first year of ownership. Hydradyne strengthens our number of one fluidpower position by extending our footprint across the southern us where they operate with a team of nearly 500 associates out of 33 locations.
Hydradyne also brings strong technical capabilities that complement our current fluidpower service and solution portfolio with approximately 30% of sales tied to repair, engineering and design, system fabrication, hose assemblies and other value-added solutions.
Our combined technical capabilities and access to premier fluid power, motion, flow control and automation technologies present a powerful value proposition for our customers that will accelerate cross selling and market penetration. This includes enhancing our collective efforts to serve the rapid pace of innovation developing across fluid power systems.
Our strategy and teams are aligned to support thousands of specialized OEMs and industrial manufacturers, engineer design and integrate these advanced features into their mobile and industrial equipment with world class technologies from top fluid power suppliers. The strength of our combined technical teams and footprint will also allow us to more effectively and broadly capture growth opportunities developing across emerging in markets and commercial applications.
We provide more detail around Hydradyne acquisition in slides 5 and 6 of our second quarter earnings presentation and Dave will cover off on some of the key financial considerations including our initial accretion expectations.
In summary, we're very excited to welcome Hydradyne and their capabilities to the applied platform. Overall, I'm encouraged by the progress we are making with our strategy including the ongoing buildout of our engineered solutions segment.
Following the Hydradyne acquisition, the segment is now approaching 40% of overall sales compared to 15% 10 years ago. The strategic expansion of this segment has further differentiated our industry position and strengthened our competitive moat. We've established and fortified our leading market positions, building and serving critical motion, power and control systems across nearly every industrial vertical.
It's created a unique and potentially significant cross selling opportunity throughout our legacy embedded customer base while increasing exposure to faster growing in markets and secular tailwinds. It's also expanding our addressable market and allowing us to evolve and enhance our competitive position as the industrial sector and related systems advance with new age processes and technologies.
Combined with a positive margin profile and ongoing operational enhancements, we expect our engineered solutions segment to be a strong and differentiated driver of earnings growth and returns going forward.
Lastly, I'm encouraged by the ongoing capital deployment opportunities with our industry position, balance sheet and cash flow generation continue to support. Year-to-date, we've deployed over $380 million in capital focused on enhancing our growth position and shareholder returns. This compares to $251 million of capital deployed for all of fiscal 2024.
While partially reflecting our recent Hydradyne acquisition, we also continue to return capital through share buybacks including deploying $30 million share repurchases year-to-date. In addition, we announced this morning a 24% increase in our quarterly dividend. The increase is in line with our expectation for greater dividend growth as we align annual increases with normalized earnings growth, including the strong earnings and cash generation achieved in recent years.
Our capital allocation priorities remain unchanged and highly focused on organic investments and M&A. However, our broader capital deployment trends year-to-date showcase the multiple opportunities and ways we can deploy capital to optimize shareholder returns as we continue to scale our business and achieve our strategic goals.
Moving forward, our balance sheet and financial capacity remain extremely well positioned to continue to support M&A and other capital deployment opportunities. We have ongoing scope for additional buybacks for the remainder of fiscal 2025 based on our current financial capacity and the intrinsic value we see across our company long term.
In addition, our M&A pipeline and related due diligence remains active across both segments with a primary focus on bolt on and midsize targets where we can create significant shareholder value. At this time, I'll turn the call over to Dave for additional detail on our financial results and outlook.

David Wells

Thanks, Neil. Just another reminder before I begin. As in prior quarters, we have posted a supplemental investor presentation to our investor site for your additional reference. This quarterly presentation provides a more detailed recap of our second quarter results, uUpdated guidance and details on our recent acquisition of Hydradyne. Turning now to our financial performance in the quarter, consolidated sales decreased 2.4% over the prior year quarter.
Acquisitions contributed 190 basis points while the difference in selling days had a positive 160 basis point impact. This was partially offset by a negative 50 basis point impact from foreign currency translation. Netting these factors sales decreased 3.4% on an organic daily basis.
As it relates to pricing, we estimate the contribution of product pricing on year to year sales growth was slightly less than 100 basis points for the quarter and largely in line with our expectations.
Turning now to sales performance by segment, as highlighted on slides 9 and 10 of the presentation, sales in our service center segment declined 1.9% year over year on an organic daily basis. This excludes a positive 30 basis point impact from acquisitions, a positive 160 basis point impact from the difference in selling days and a negative 70 basis point impact from foreign currency translation.
The organic sales decline was primarily driven by reduced MOR spending, lower capital maintenance project activity, extended customer plant idling and the timing of holidays in the month of December.
The impact from weaker sales in late December was most pronounced across our service center operations. This followed more stable trends in October and November where segment sales were relatively unchanged year to year. Growth in national accounts during the quarter was more than offset by weaker sales from local accounts.
Segment EBITDA increased 1.4% over the prior year while segment EBITDA margin of 13.4% improved nearly 30 basis points year to year. Within our engineer solutions segment, sales increased 0.4% over the prior year quarter with acquisitions contributing 5.1% points of growth and the impact from one extra selling day, providing an additional 160 basis points of growth. On an organic daily basis, segment sales decrease 6.3% year over year.
The decline was primarily driven by ongoing sales weakness across fluid power OEM customers mostly reflecting reduced demand across mobile fluid power markets. This was partially balanced by more stable trends across industrial implant applications as well as improving demand in technology related fluid power and markets.
Meanwhile sales within our automation operations declined by a high single digit percentage year over year on an organic daily basis. This is consistent with last quarter and primarily reflects or headwinds from customers continuing to delay spending in response to macro uncertainty.
Talk of fuel power and automation sales were partially offset by ongoing growth across our flow control operations where average daily sales increased 2% year to year and over 4% sequentially reflecting firm project activity on process infrastructure. In addition, despite the sales decline in the quarter segment, EBITDA increased 8% over the prior year while segment EBITDA margin of 16.3% expanded 115 basis points from prior year levels.
The performance primarily reflects strong gross margin expansion tied to our internal initiatives and value proposition, more favorable mix and to a lesser extent, lower LIFO expense as well as contributions from ongoing operational enhancements as we continue to execute our engineer solutions strategy. We were to consolidate gross margin performance as highlighted on page 11 of the deck, gross margin of 30.6% increased 114 basis points compared to the prior year level of 29.4%.
During the quarter, we recognized LIFO expense of $0.7 million compared to $3.4 million in the prior year quarter. This net [LIFO] tailwind had a favorable 25 basis point year to year impact on gross margins. Excluding this impact, we still generate solid gross margin expansion in the quarter despite ongoing mix headwinds tied to lower sales across our engineered solutions segment and local accounts.
Underlying performance reflects the strong channel execution our engineer solutions segment performance and the benefits of ongoing margin initiatives.
As it relates to our operating cost, selling distribution and administrative expenses increased 2.3% compared to prior year levels.
SG&A expense was 19.3% of sales during the quarter reflected an increase of 51 basis points from the prior year quarter. On organic constant currency basis, SG&A expense was up 0.3% over the prior year period, but down over 1%. When adjusting for the extra payroll day in the quarter. Our team did a nice job controlling costs in the quarter against the muted demand backdrop while managing inflationary pressures in order to continue to balance and sustain critical investments for growth.
We also benefit from ongoing efficiency gains and reduced variable expense on lower sales which help balance higher administrative and occupancy costs.
In particular, the quarter included approximately $1.5 million of due diligence and transaction related expenses related to the Hydradyne acquisition. Overall, positive gross margin performance coupled with the benefit of spend initiatives resulted in reported EBITDA increasing 3.3% year over year while EBITDA margin of 12.6% expanded 45 basis points from the prior level of 12.1%.
Combined with greater interest income on higher average cash balances and a slightly reduced share count, we reported earnings per share of $2.39 which was up 6.7% from prior year adjusted EPS levels of $2.24. Of note, prior year adjusted eps excludes a pretax $3 million or $0.08 per share deferred tax valuation allowance benefit.
Moving now to our cash flow performance, cash generated from operating activities during the second quarter was $95.1 million while free cash flow totaled $89.9 million, representing conversion of 96% relative to net income. Year-to-date, we have generated approximately $212 million of free cash flow which is up 34% year over year and represents a conversion of 114% relative to net income.
Our cash flow growth so far this year primarily reflects more modest working capital investment compared to prior year as well as ongoing progress with internal initiatives and our enhanced margin profile.
Turning now to our acquisition of Hydradyne. As Neil mentioned, we were extremely excited about this transaction. It represents another notable milestone for Applied and our overall value proposition to customers, suppliers and all stakeholders.
Not only does the acquisition fit extremely well with our M&A priorities and return based capital deployment strategy, Hydradyne's local customer centric culture and operational caliber aligns well with our operating framework which will provide a strong foundation on which to build positive momentum early on. As it relates to some of the financial considerations of the deal, the purchase price of $276 million was funded with cash on hand representing a transaction multiple of 9.1x enterprise value to forward EBITDA before anticipate its energies.
We expect the transaction to generate approximately $260 million in sales and $30 million in EBITDA as well as be accreted to EPS by approximately $0.15 within the first 12 months of ownership. The EPS accretion estimate is net a projected acquisition and tangible amortization expense of over $11 million in the first year or $0.22 per share as well as reduced interest income on lower cash balances after funding the transaction.
In addition, these assumptions are before anticipated synergies tied to cross selling, leveraging complementary solutions, harmonizing technical capabilities and systems and driving operational efficiencies across the combined operating platforms. We expect synergies to begin to develop in fiscal 2025 but be more meaningful in fiscal 2026 and 2027.
Based on our initial projections, we are targeting net synergies of $5 million to $10 million within the first three years of ownership. Of additional note, following the transaction, our balance sheet remains strong with pro forma net leverage, increasing to a modest 0.5x and approximately $1.5 billion of balance sheet capacity remaining.
Turning out our outlook as indicated in today's press release and detailed on page 14 of our presentation, we are raising full year fiscal 2025 guidance to reflect our stronger second quarter earnings performance and estimated initial contribution from our acquisition of Hydradyne. We now project eps in the range of $9.65 to $10.05 based on sales growth of 1% to 3% and EBITDA margins of 12.2% to 12.4%.
Previously, our guides assumed EPS of $9.25 to $10 sales growth of down 2.5 % to 2.5% and even the margins up 12.1% to 12.3%. Our updated guidance assumes full year fiscal 2025 sales declined organically by 3% to 1% on an average daily basis compared to our prior assumption of down 4% to up 1%.
We are now assuming year over year organic sales trends improve more gradually in the second half of fiscal 2025. We believe this is reasonable given ongoing uncertainty tied to macro policy and interest rates which could continue to restrain customer capital spending and production growth near term.
We're also taking into account the slower start to early third quarter organic sales trends which as noted earlier are trending down by a mid single digit percentage over the prior year January. The midpoint of guidance now assumes average organic sales decline by a single digit percent year over year in the second half of fiscal 2025 including mid single to low single digit declines in the third quarter followed by a return to modest growth in the fourth quarter.
We are projecting M&A generated sales including Hydradyne to contribute 600 basis points to 700 basis points of year over year sales growth in the second half of the year, partially offset by ongoing foreign currency transaction and translation headwinds. Overall while we remain constructive on our set up moving forward considering easier prior year comparisons, improving demand indicators and sustained benefits from our internal initiatives, we believe a balanced approach to our near term outlook remains appropriate any more definitive signs of a positive inflection and underlying industrial activity.
Lastly, from a margin perspective, we expect third quarter gross margins to decline sequentially to around 30%. This assumes a more normalized level of gross margin and execution relative to our strong second quarter performance as well as slightly higher LIFO expense.
Combined with ongoing inflationary headwinds, anticipated growth investments, our annual merit increase which was effective 01 January and initial integration costs mixed considerations from Hydradyne acquisition. We expect third quarter even the margins to moderate sequentially to 12% to 12.2%. Those still expand year over year.
Lastly, our updated guidance assumes initial EPS accretion from hydrazine is modest in the third quarter as we begin integration and align initiatives within a muted and market backdrop. We expect accretion to begin to ramp in the fourth quarter and in the fiscal 2026 as initial synergies are achieved and end markets begin to recover. With that, I will now turn the call back over to Neil for some final comments.

Neil Schrimsher

So to wrap up, I'm proud of the Applied team and our performance through the first half of fiscal 2025. We're delivering on our commitments and making strong progress toward our interim financial objectives of $5.5 billion of revenue and 13% EBITDA margins near term. We believe the underlying demand environment could remain muted and somewhat choppy pending a more defined direction macro policies post the election.
As our second quarter results show we have the ongoing self help opportunities to manage and perform well if demand remains sluggish near term. That said as we look forward and consider our industry position, we continue to believe we are close to entering a very favorable growth period at Applied. We feel good about the positive demand signals developing, including stronger order trends across our higher margin engineered solutions segment. Investments over the past several years should optimize our organic growth potential as in markets begin to recover.
This includes recent facility expansions to optimize our service capabilities across the technology vertical and our automation operations. A recent board meeting was held at one of these facilities where we saw firsthand the growth potential of our expanded capacity and technical market position as well as some of the building customer activity beginning to develop.
We also believe break fix activity should accelerate across our service center network into the spring and summer as production schedules ramp back up. This could drive more heightened technical MRO and capital spending as customers reengage initiatives to modernize equipment and expand production facilities now with the election behind us and as additional transparency develops on us trade policies and interest rates.
Our technical domain expertise and access to core industrial equipment puts us in a leading position to help customers manage through these operational requirements.
Lastly, we're in a strong position to benefit from ongoing industry consolidation over the next several years, considering the high fragmentation and technical requirements associated with our industry segment. We believe the drivers of consolidation are higher today. Customer supply chain focus has intensified, they are potentially facing one of the more favorable us manufacturing backdrops in decades while also managing through limited technical labor availability and greater mandates to eliminate operational risk.
Accelerating innovation and significance of motion power and control systems and are increasing service requirements including access to new production solutions and system repairs. Combined with structurally higher inflation, we believe these considerations could accelerate consolidation across sector both organically and through M&A as customers and suppliers increase business with larger more capable distributors.
The value of our scale technical service, engineering capabilities, strategic supplier relationships and available balance sheet capacity has never been stronger in our marketplace. Overall, we look forward to fully capturing this growth potential through the remainder of fiscal 2025 and years to come. And as always, we thank you for your continued support. With that, we'll open up the lines for your questions.

Question and Answer Session

Operator

(Operator Instructions)
David Matthew, Burt.

David Matthew

Thank you. Good morning, everyone. The first question is in the second quarter excluding rebates and the lifo tailwind you improved core gross margin by about 80 basis points year over year. And one of the slides, you mentioned execution e segment and initiatives. I'm wondering if you can further refine the sources and the sustainability of that improvement.

Neil Schrimsher

Yes, I can start, David. I would say in the energy segment, good performance, we got benefit from mix scale is coming through for us into that side. And so we think just overall good execution as the team looks to appropriately price to the value of the systems and solutions that we have. So positive and point of sale there, but also benefit in the technical nature of the products and solutions mix as well as some of the customer side in that.
I think as Dave pointed out, we did get some supplier benefit into the side. I would say roughly 10 basis points to 20 basis points of that that could have been or that was tied to achieving a higher tier into that side. So it came through into this quarter. We would not look for that to replicate in the third quarter. And that really points us to saying gross margins are more low 30s percent in the third quarter and the rest of the back half. But we did get, another 10 basis points to 15 basis points of just good continued execution across the business as well.

David Wells

You get your point, Dave. Stripping out that unusual support vendor support in the LIFO which combined 10 basis points to 20 basis points on the vendor support, 25 basis points on the Lifo. Solid in line performance. About 50 basis points of that did come out of the interior solutions segment, combination is new indicated mix. I mean, a big piece of that reading through is as we said, we were up 2% year over year in terms of our flow control, shipments up 4% subsequentially. That is one of our richer gross margin performing businesses as well as just, here again, pricing for the value and some of the favorability that we're seeing coming out of that segment.
But beyond that, proud to see the 5 basis points to 15 basis points improvement in the service center side of the business. So really hitting all the cylinders there with the community to work around operational efficiencies, pricing in both pieces of the equation and really maximizing the benefit and the market position that we do hold.

David Matthew

Okay. Thanks for the detail there. And second, Dave maybe you could talk about depreciation and amortization due to the acquisition of Hydradyne separately. Just what is the step up there? And then also related to Hydradyne, you mentioned today, $5 million to $10 million of synergies over the first three years. I'm wondering number one, is that a run rate by the time you hit the end of three years? And then second is that cost synergies or sales synergies or both.

David Wells

The majority. It's about, let me see, 70 to 30 mix in terms of sales energies, cost energies. We'll get those by virtue of benefits harmonization, leverages some of our licensing for both businesses, our legacy, fluid power business and Hydradyne on an epic core product that we do have some very favorable licensing costs for.
And then you do anticipate some obviously the sales energy coming through as we continue to leverage and particularly given the underserved nature of that South East region that we've been looking to enhance our position in for so long as we targeted this acquisition, you see some of that come through. So a combination of both, the 22% impact in terms of depreciation amortization expense as we talked about stripping out specifically Hydradyne.

Ryan Cieslak

Maybe I'll take that one just as it relates to the depreciation of an amortization into the back half. You know, we'll step up to in total, closer to $17 million per quarter. And so Hydradyne including the entangled amortization as well as the depreciation about $3 million of incremental DNA or depreciation amortization per quarter in the back half of the year.

Neil Schrimsher

And Dave I'd say then as we think about the synergies as we break them out, we think the cost margin side is in that more 70 to 80 end of that. Obviously a scale help us some in that we think on the on the purchasing side some of the indirect support.
But with that said, we're excited about the additional sales synergy opportunities and perhaps in that 20% to 30% range that that opens up to leverage the capabilities, strong service and repair and solutions in the geographies that can link with the service centers in and then the acceleration that we think across those in market segments in electronic controls, perhaps electrification in time will open up some of the cell synergies as well. So overall, very excited about this strategic addition to us in a core focus area of fluid power and an important geography.

David Matthew

I appreciate the detail. Thank you.

Operator

Ken Newman, KeyBanc Capital Markets.

Ken Newman

Thank you. Good morning, guys. First I just wanted to clarify Neil on the January trends, turning down mid single digits. You know, I think it makes sense that it's being impacted by some of the holiday timing that you saw in December. But I am curious if you have any color on what the weekly trends through the month or how the ABS trends have kind of shifted from the beginning of the month towards the end and whether or not we're back to preshutdown levels or when you expect us to get there.

Neil Schrimsher

Sure. And so I would say Ken, most of the drag in January was early in the month and I'd say probably the first couple of weeks down, double digit. I would really say the last couple of weeks up low, single digit, a few days to go here as we move through. So that would be the break. And so that builds part of our view that it's hard to extrapolate all in November, December and the early start of January as the full indicator. So we're encouraged by the pickup over the last couple of weeks.

Ken Newman

Right. That's very helpful. And then Neil you know, you're essentially at your 40, 60 segment mix between the engineer solutions and service center businesses. Do you or the Board have a sense of where you want that mix to ultimately go from here. And how do you envision the pace of that makeshift change from the growth that you've seen in the last five years.

Neil Schrimsher

So I think we've got still great potential on both segments. You know, we talked about it time to get to the perhaps the 60 service center 40 approaching that. With that said, opportunities on both segments to organically grow, cross sell opportunities that help vote as well as future M&A. Could anticipate engineered solutions growing past 40% in time to 45% or 50%, a good healthy balance across the business?
Absolutely. But that will play out and there will be, continued opportunities for boltons on the service center side. But if it stabilizes out and at a future date at a good, healthy 50 to 50 with both profitably growing. That will be a good spot for the company.

Ken Newman

Yes, that's helpful. Maybe if I could just squeeze one more in here. You talked about the year-to-date engineered orders being up year over year driven by automation and tech. Just to clarify, are you, is the expectation that those, the revenue growth in those subsectors flip positive here in the second half. And maybe just some color on where the automation business is run rating from a revenue perspective today.

Neil Schrimsher

Yes, I'll start and work backwards. That's a run rate of the automation businesses probably in that 240 type range around that, on the side. We did touch on order rates encouraging automation in the high single digit tech double digit in that front. But, collectively good activity broadly in engineered solutions may be more low single digit with the broader impact that we've had in fluid power in the off highway mobile segment. But as we talked in the remarks, a little bit of an improvement there that we think could be encouraging as it goes across.
As far as the conversion timing, it really depends. Some of them are very, quickly in conversion other that have a more technical nature or complexity in the buildout could be 120 perhaps more days into the side in that technical conversion the site. So it really depends on the application of that conversion or where it fits in with the customer and their overall project, which that can also cause some slotting or timing impacts as well.

Ryan Cieslak

And then Ken, as you think about the guidance by segment from a topline perspective, I think there is relates to the down mid signal to low single digits organically in the third quarter. We think the segments could probably trend around that in a somewhat similar way this quarter. And then if you get into the fourth quarter, there's a path clearly given the order trends that we've seen in the engineered solutions segment to start to see the segment grow a little bit above where we see the service center segment from that standpoint.

Ken Newman

Very helpful. Appreciate the call guys.

Operator

Chris Dankert, Loop Capital Markets.

Chris Dankert

Hey morning guys. Thanks for taking the questions. I guess, congrats on the quarter. We're looking at gross margin here, the delineation, there was very helpful. I guess anything to call out on the freight side, that was a tailwind in the quarter. How do we think about maybe freight going into the back half of fiscal '25 here.

Neil Schrimsher

Chris, I'll start. I'd say nothing significant to call out. Teams continue to have a good focus and execution freight and we will continue that emphasis. We know the importance of it. So I don't think a material input in the quarter nor a big change in expectations for the back half.

David Wells

Rates have gone up significantly. We do have some nice contractual pricing, and the team is very focused on freight recovery and you know, kind of matching that. So really not a move for us either direction as we've seen some of the ebb and flow of this freight cost.

Chris Dankert

Helpful. Thank you so much there. And then maybe just zoom out to the 30,000 ft for a second. You know, a lot of talk around changes to the US MCA. I know we've been hearing some better investment conversation from your metals customers, anything else that you're you're hearing or trying to keep in mind around trade talk and kind of how customers are positioning themselves here.

Neil Schrimsher

So if we think about that, we have very good business and operations in Canada, in Mexico. A large portion of that is that they're highly contained and serving customers and segments. In Mexico not only the service centers include power, recent strong addition in automation with [CoPAR] in that front. So, to date, we think that's potentially lower impact to be determined the views on tariffs and what that impact can be in that front or is it to get improvements on immigration and perhaps drugs and some other policies in that.
But, to date our view is, it will not have a significant impact in US and in those countries. There can be adjustment. If I look back at Trump policies. You know, 1.0 we were very effective at managing the tariffs and the impacts in the 232 and the various 301 list into that, we still have that in our playbook. You know, if or when those tariffs develop, we'll know how to execute.

Chris Dankert

Understood. Thanks so much guys.

Operator

Sabrina Abrams, Bank of America.

Sabrina Abrams

Hey, good morning, guys. You talked about, I guess pricing coming in a little under 100 bits this quarter. Just wanted to ask about the behavior you're seeing from suppliers on pricing. Do you feel you're caught up on price cost has pricing sort of normalized. And just any signs of this inflation, maybe color by product line would be helpful as well.

Neil Schrimsher

Yes. So Sabrina, I can start. I would say really no signs of disinflation. I would say the amount of the increase, the frequency and the rate are similar, suppliers probably organize around a couple of buckets. Some will be now a calendar year end and start, and some others will operate more perhaps off their fiscal calendar and there'll be a grouping of suppliers there.
If you think about overall dynamics, there still would be inflationary inputs around labor for many of our suppliers, there's inflationary inputs on general and administrative expenses, medical health care into those sides. And perhaps, metals inputs can vary into the front. But what we are seeing is that the rate of increases have more normalized as we look back or think back all the way to the pandemic of being more once per year and the size of the increases are more normalized.
And of course, that's all dependent on or pre any tariff impact. And I think their suppliers are clearly aligned. If tariffs develop on some of those items, they will come through as increases to the product prices, not any just auxiliary cost. And so it would result in inflation. But all that said, right now to your point in the remarks, less than 100 basis points impact if we -- that would be our current expectation for the back half of the fiscal year of aside of any other significant policy changes.

David Wells

You know, I'd reiterate call it normalized in terms of the pricing that we do continue to see. And you know, really, you might jump to the conclusion that the lower LIFO expense was a result of, kind of lower price inputs really more of a function in this case of the reduction in operating inventories we've continued to achieve. Operating inventories sequentially continue to normalize in the quarter down about 2.5% sequentially or $18 million.
So you took some of the pressure off the LIFO CALC and lowered some of that expense in the quarter. But here again, we had to call it more normalized and that good steady inflation, that distributors like because we know how to take that, you recover that and pass it on.

Sabrina Abrams

Thank you. And then we talked about this a little but can you give a color on why gross margins moderate Q over Q, I guess there's 10 bits to 20 bits from the supplier rebates that I think you said doesn't repeat. But there's a remaining 40 bits, 50 bits of sequential moderation and just like wondering if it's mixed Is it sourcing is the price cost? How should I think about the moderation.

David Wells

A combination of mix. And then we did say we do assume, step up from what we saw in the most recent quarter in terms of LIFO, just not expecting to reduce the inventory levels further to that order of magnitude. So we'd see LIFO expense step back up. We've got in, kind of around another million or so each quarter.
So that's where the biggest drivers and you know, just seeing some of that mix impact normalized would be the other factor as I look at the equation the expectation for some of that normalizing in terms of the gross margin performance.

Operator

Brett Lindsay, Mizuho.

Brett Lindsay

Hey, good morning. Thanks for the questions. First one just on the tariff situation. So obviously, it's still a bit unclear on where those might land, but you did note additional policy transparency would certainly be good for demand. Just curious what you're hearing from customers in terms of a potential pre buy activity ahead of any tariff related pricing and how that might work through the channels.

Neil Schrimsher

So it's a brit for us and given the supply base and that many of the products can either be domestically or North America produced in that area, right? We're low direct import. Some of our suppliers may have componentry to adjust in the time. I do not see heightened prebuy activity on products. I think most are taking the stance if or when they occur, there'll be some notice period to do that. Perhaps there'll be some existing inventory in the channel and end customers are prepared to take it forward to the marketplace as well.
And so if there are tariffs, right, it can have an inflation there impact on that will need to pass all the way through the businesses all the way through the channels and to the end users, the end consumers in that. And so I do not see a big move to get in front because there's not really the understanding of the clarity of what went on last time does that repeat or is it going to be different.

David Wells

I'd add to that. We think about 50% of our service center business being break fix and, not really being able to anticipate what they do need. That's another dynamic that. We don't see as much stocking, destocking in this business as a result.

Brett Lindsay

Makes sense. And then just, just a follow up on M&A so you noted a number of bolt on and midsized deals in the pipeline, maybe just talk about the near term actionability of the pipeline for Hydradyne deals. And then if there's any constraints on, management integration resources or anything to do a couple more of these chunky midsize deals and, and maybe what's behind it. Thanks a lot.

Neil Schrimsher

So I'd say the business, the team say clearly we have the operating capacity and the capability to do these across our businesses, whether it be fluid power flow control and automation. You can imagine the teams start to turn in the operating teams slightly different in those as well as the service centers. You know, I said, we can't perfectly control the timing on these as well.
We did touch on that business, the expectations, the requirements of customers into that side. I think it will cause more businesses to look and consider. And so we just plan on like we are really in all periods, stay active to our priorities with those companies, with those prospects and with those targets.

Brett Lindsay

[Patrick Susrait], Oppenheimer.

Hey, guys, I was wondering if you could give us some background on the history you have with Hydradyne leading up to the deal. You know, what most attracted you to it and any incremental learnings and cross selling potential or the technical capabilities you lifted that you may have had in your first month of ownership as you get a better look under the hood.

Neil Schrimsher

So Patrick, I'd say one, a very good business that we've known for an extended period of time from a geographic standpoint. It was not an area that we had from a food power company standpoint, really the reach and the participation so helps us very much there. I would say very similar from a value added solutions approach into that both in industrial, in market applications as well as mobile on and off highway in the front.
A lot of good service and repair capabilities. So we think given our service center participation across businesses that can fulfill some of the service and repair needs of those customers effectively in those served geographies. So it's early, but a very good team, very good approach in doing it, we'll be smart about the business operation and the integration and how we go forward.
We think we have good line of sight to margins that combine with the businesses around scale and cost and on the margin side as well as it will open up more synergy opportunities on the selling side for us over that time period. So again, a very good strategic fit in the geography, a lot of capabilities fitting our engineered solutions build out priority especially around the fluid power side.

Okay. Thanks for that. You guys mentioned ample capacity for more M&A and you know, Brett asked about the size, but I'm curious what the pipeline looks like now regarding strategic focus areas, you guys prioritizing additional targets and fluid power or would you view other product areas more likely for excessive pursuits?

Neil Schrimsher

So we would continue to have good prospects and targets in fluid power as well as flow control and automation, a little more select but opportunities are built out on the on the service center side with effective leverage at 0.5x now, post acquisition. So we still have a ready capacity and capability to continue to be acquisitive in this. I mean, we've said the business can clearly operate with two turn two times leverage in an environment.
And so obviously, to talk about two, you've got to get the first in that front. Very good opportunities for us in that business has strong capacity and it will be part of our continued build out as we get to the next level targets of the $5 billion in revenue and 13% of margins. We will continue to grow organically as well as right acquisitions.

Okay. Thanks. I'll pass it on.

Neil Schrimsher

Thank you.

Operator

At this time, I'm showing we have no further questions. I will now turn the call over to Mr Schrimsher for any closing remarks.

Neil Schrimsher

All right, simply I want to thank everyone for joining us today and we look forward to talking with many of you throughout the quarter. Thank you.

Operator

Thank you, ladies and gentlemen, this concludes today's conference. Thank you for participating. You may now disconnect.